James Bevan: Optimism of the herd may be good news in the short term for investors

Some trustees consider it odd that we are cautious on prospects for many economies but still bullish on the near term outlook for many risk assets. But this apparent inconsistency is reconciled by the observations made by Keynes in his “General Theory” in 1936, that the art of investing is to predict not what will happen next, but rather what the crowd will expect to happen next – and it looks as if the consensus will expect, and indeed is already beginning to expect, some form of synchronized global economic recovery in 2015. In part, this may reflect the optimism of human nature and the season, and in every year since 2008, markets have ended the year and begun the New Year expecting that the year ahead will be when the economy blossoms and leaves behind the shadow of the global financial crisis. Key components of the positive story board are the belief that China will return to double digit growth, that Abe-nomics will gain traction, that US consumers will lift their rate of spending growth, and that there will be a sharp improvement in capital expenditure.

Against this backcloth, we should expect surveys and sentiment indicators such as the Purchasing Manager series (PMIs) to improve, and the underlying data for these indices are themselves subject to the affects of human optimism, with New Year rallies typically based on expectations components rather than conditions experienced. One challenge is seasonal adjustment and the timing of the hugely significant slump that followed onset of the global financial crisis, and also the timing of the subsequent massive fiscal response. The combined effect is that surveys tend to read ‘high’ between December and March (inclusive) but too low in the second quarter.

Apart from the surveys, markets may expect 2015 to be a better year because of the pro-growth policies set to commence in the early part of the year, with the expectations that China’s central bank will cut interest rates and reserve requirements in early 2015, the Bank of Japan’s latest moves and the weaker Yen will help its economy and there’ll be some form of fiscal stimulus, there’ll be positive policy news from Korea and India and the European Central Bank will follow the rhetoric with action. Commentators as also talking not just of strong capital spending in the US but also the hope that firm house prices will support spending and that economies will follow the UK into expanding credit, despite weak capital adequacy and regulatory constraints for the banks.

Put simply, many investors expect governments to drive up aggregate demand, and are comforted by recent economic data, particularly from Asia with Taiwan and Singapore both delivering better export figures. Japan has also provided some better data and the US labour market numbers have been strong, even if retail spending has apparently lagged. In Europe, some of the German data have been brighter and the UK numbers have been satis even if softer than some were expecting. Critically, releases have not only been taken by the markets as a sign of better things to come, but have also resulted in an improvement in some of the more closely watched indicators of world trade, such as airline freight data.

But digging in the detail behind the recovery in some of the economic data reveals a series of special factors. Thus, better weather has helped with Japan’s domestic numbers and the revival in both German and Japanese orders last month reflects what looks to be a one-off surge in orders for agricultural machinery from China, whilst Singapore’s better data seem to be down to specific domestic fiscal easing and a slowdown in the local property market, and Taiwan’s production data and much of the Asian airfreight data have been lifted by Apple’s product cycle, with signs that this effect is wearing off. Also much of the remainder of the improvement in airfreight trends was concentrated within carriers from the Middle East and oil price weakness suggests that this must be at risk, and similarly, Russia’s economy looks to be deteriorating and this will hurt other CEE economies.

It is apparent from the detail of the data that some of the recent pick up in Asian export volumes required heavy price discounting and world trade price deflation may now have accelerated to around 4% year on year, worryingly close to the 5–6% level historically associated with the onset of crises.

Looking ahead, we can reasonably expect a modest revival in economic growth rates in the near term but these may fade though 2015, given that there are still structural problems within the global economy, with weak household income trends and no sign that Euroland and North Asia want to embrace meaningful supply side reforms that could lift both productivity and real wages.

Our conclusion is that markets will ‘buy the story’ of imminent global recovery and this will be reinforced in the short term by the numbers reported – but we also expect that by this time next year, markets will have turned more pessimistic on the outlook for growth, unless Euroland and Asia surprise us by introducing real reforms.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla

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